Share Rental Agreements
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Last week, cash rental agreements were discussed and now crop share rental agreements. For crop share rental agreements, both landowner and tenant share crop expenses and also the crop. This involves much more involvement of landowners in the farming operation. The landowner has the land while the tenant supplies the labor and the equipment for farming the crop. Since the landowner has more risk, usually the return is expected to be higher, but they also have to have more cash outlay. For newer farmers or for cash strapped tenant farmers, this can be helpful, lowering the tenant cash outlay and risk, but the tenant should expect lower total returns.
Share crop agreements are much more contentious and require more time to manage. It requires more trust and transparency into more farming decisions. Since market conditions vary from region to region and from year to year, they often have to be renegotiated on a yearly basis. Again, there are advantages and disadvantages to share crop agreements.
On the plus side, operators need less cash to get started. Sometimes a retired landowner who was a farmer has extensive farming knowledge and may share that knowledge with a new farmer. Often this works when a relative is passing the farm operation to a new family member. Farm sales can be managed better for tax purposes to minimize taxes. While the risks are shared, so are the profits and losses shared between the two parties.
Since the landowner is now part of the management of the farm and sharing the risks, the landowner has “material participation” with crop production and marketing, so there are some federal benefits for federal estate tax considerations. Also, since crop share income is subject to self-employment tax, the advantage is that the landowner can build up their social security base, however; the downside is you have to pay social security taxes.
On the disadvantages, landowner returns will vary from year to year. The landowner benefits from higher prices and good crop yields, but they also lose when the opposite occurs. All expenses have to be accounted for in this type of shared arrangement, so it takes more paperwork. It is not uncommon that this also creates more friction in a farming relationship. Landowners often have more responsibility for marketing their crops. Sometimes crops are marketed together, but the landowner and tenant may have different needs for money at different times of the year. Again, a chance for more friction. The landowner and the tenant need to be good communicators and be able to resolve their differences.
Here are a couple of rules that help with share rental agreements. Variable expenses that increase yield are shared in the same percentage as the crops are shared. Often new technology may change the costs shared by the parties. On the other side, rising land prices can do the same thing. The landowner needs to list the resources they supply and compare that to the resources that the tenant supplies. Then total returns should be allocated in the same portion as the resources supplied. That allocation may change quickly, so good record are needed. Operators need to be compensated upon termination of a lease for any undepreciated balance of long-term investments. For example: tile, possibly lime, or large fertilizer investments. It takes a lot of communication and trust between parties to operate a share rental agreement.
Sometimes, landowners and tenants can also share risks and income by adding flexibility to a cash rental agreement. Crop prices and yields vary from year to year as do input costs for seed, chemicals, fertilizer etc. During highly profitable years, landowners can sometimes get bonuses from unexpected increases in crop prices or yield.
For example, some flexible cash rental agreements flex for crop prices only. As prices increase, the landowner gets a higher cash rent. The disadvantage for the tenant is that if crop prices rise but yields drop, the tenant has more variable income risk. Another option is to flex the cash rent based on yield. Often, this type of agreement is used in areas where the crop is fed to livestock (example silage) and crop prices are hard to determine.
The most popular flex cash rent agreements adjusts for both crop prices and yield. A base cash rent is usually established based on average yields and average crop prices and then adjusted as crop prices and yields vary. Finally, some agreements also adjust for input costs, especially when fertilizer, fuel, and/or chemical prices get really high. All rental agreements should be put in writing and reviewed on a regular basis. For more information visit the https://aglease101.org/ website.
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